Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. Â This isÂ best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another companyÂ or by reviewing theÂ 5 Most Undervalued Companies for the Defensive Investor – February 2015.Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a specific look at how Reynolds American Inc. (RAI)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance):Â Reynolds American Inc. is a holding company. The Company operates through three segments: RJR Tobacco, American Snuff and Santa Fe. The RJR Tobacco segment consists of the operations of R. J. Reynolds Tobacco Company. The American Snuff segment consists of the operations of American Snuff Co. The Santa Fe segment consists of the operations of Santa Fe Natural Tobacco Company, Inc. (SFNTC). Niconovum AB, Niconovum USA, Inc. and RJR Vapor are among other RAI subsidiaries, which are included in All Other. The Companyâ€™s products brands include Camel, Pall Mall, Winston, Kool, Doral, Salem, Misty, Capri, Dunhill, State Express 555, Grizzly, Kodiak, Natural American Spirit and Vuse Digital Vapor Cigarettes.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years -Â PASS
- Dividend Record – has paid a dividend for at least 10 straight years -Â PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period -Â PASS
- Moderate PEmg ratio – PEmg is less than 20 -Â FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 -Â FAIL
- Earnings Stability – positive earnings per share for at least 5 years -Â PASS
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â PASS
|Value Based on 3% Growth||$38.41|
|Value Based on 0% Growth||$22.51|
|Market Implied Growth Rate||10.03%|
Balance Sheet – DecemberÂ 2014
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
Reynolds AmericanÂ Inc.Â is not suitableÂ for the Enterprising Investor orÂ for the Defensive Investor. Â The Defensive Investor is concerned by the the low current ratio, and the high PEmg and PB ratios.Â The Enterprising InvestorÂ is concerned by the level of debt relative to the current assets. Â As a result, value investorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should exploreÂ other opportunities at this time. Â From a valuation side of things,Â the company appears to be overvaluedÂ after growing its EPSmg (normalized earnings) from $1.96 in 2010 to $2.65 for 2014. Â This level of demonstrated lack of growth doesn’t support the market’s implied estimate of a 10.03%Â annualÂ earnings over the next 7-10 years, leadingÂ the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value belowÂ the price.
Be sure to check out previous ModernGraham valuations of Reynolds American Inc. (RAI)Â for greater perspective!
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on Reynolds American Inc. (RAI)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
Disclaimer: Â The author did not hold a position in Reynolds American Inc. (RAI)Â orÂ in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.